ECO501 Economics For Managers Learning

The law of demand states that when the prices of different goods and services rises, their demand falls. This means that in increase in the prices will lead to a reduction in the consumption of those goods and services. The law of demand is applicable to food just like other goods and services because the demand for food faces both substitution effect and income effect (Varian 2014). A rise in the price of food leads people to substitute different kinds of food. For example, with a rise in the prices of food, the food demand would shift toward home cooked meals from having meals at restaurants. This rise in prices will also lead to a negative income effect as the overall food purchase by the consumers will fall. However, in both cases the higher food price leads to a decline in the quantity.

 

Substitution effect is a concept of consumer choice theory where when the price of a particular good changes the pattern of consumption also changes that is with the change in the price, consumers will change their consumption decisions and consume higher quantities of the good whose price is low and reduce their consumption of the good whose price is relatively higher (Friedman 2018). Substitution effect has ways of affecting food prices because when a particular food item is being substituted for another food item then the price of the substitute starts to rise as a response to the rise in its demand while the price of the food item that was substituted falls due to a fall in its demand. When the food price rises people usually substitute that food for another food or another activity (Leamer and Stern 2017). People react by substituting cheaper food items when other food items become more expensive. People also often change their diets and food intake with a rise in the food prices.

 

 

Income effect is the change in a consumer’s discretionary income and is caused by a change in the real income of the consumers. When the prices of goods change, the nature of food is a normal good and therefore a rise in the price of food leads to a fall in the real income of the consumers. When the price of the goods and services changes, it leads to a change in their real income and then the consumer will lower his demand for the higher priced goods or services. This effect is called an income effect (Becker 2017). A normalgood is a necessity item and the demand of this good depends on income changes but the rate of change is lower than the rate of change in income. The income elasticity of demand for normal goods is positive but less than one. This income effect leads to a fall in the quantity demanded. In the food sector in the US, many restaurants have to face a negative income effect caused by a high price in food. This is because people tend to cut down on their food consumption in the restaurant. With lesser trips to restaurants, the kind of food consumed would change. While consuming at home, consumers would opt for consumption of more noodles and less steaks. However, the response is different for the poorer countries. In the case of poor economies, the consumers would cut down on their overall consumption of food as a response to a rise in food prices. Further in case of countries facing extreme poverty, food price rises will lead to increased starvation (Stiglitz and Rosengard 2015).

• Land prices are rising due to the policy measure by the government to reduce the supply of new land in order to encourage urban densification. This shortage of supply has led to its price rising (Jacobs 2015). This directly contributes to the rising housing prices. Other reasons are greater availability of credit due to financial deregulation and low interest rates since the 2008 (Kohler and Van Der Merwe 2015). the causes behind this rise in housing price is given as below:
• Credit is made more easily available due to deregulation
• Interest rates are low as they have been kept low since the 2008 crisis. This was done to increase borrowing by lowering repayments
• Government restriction on the supply of land
• Average area of houses are increased
• The prevailing tax system favors the current house owners and investors as they stress on negative gearing and capital gain tax discount policies
• Government regulations that discourage high density of land use
• Government initiative of ‘urban densification’ put restrictions on greenfield development
• The high rate in the population growth
• Changes in foreign investment rule for the temporary visa holders
• Local councils were introduced to levy upfront infrastructure.
• The effect on the housing prices is well explained by figure 1. Since the government has taken up urban densification as a policy measure, this would mean that the supply will be limited as the government will make a lot of land area unavailable for construction (Connolly, La Cava and Read 2015). The aim of urban densification is to have more residential buildings in the urban areas which are more centrally located instead of the out strips which are preferred due to their nearness to the beach. This shortage of supply is coupled with the ever increasing demand due to a constant rise in the population. The demand curve for housing is given by D the supply curves are given by S and S The limitation in supply or shortage results in a rise in the prices in the housing market which has been reflected by a shift in the supply curve to the left to curve S₁ from S and prices therefore rise to P_1.

Figure 1: Fall in the Housing Market Supply

Source: Created by Author.

In metropolitan cities, the supply of land is inelastic but not perfectly inelastic as there can still be some amount of land available for the construction of buildings by converting the farmlands which are present in the outskirts. Perfectly elastic would mean that the supply of land is fixed but in case of metropolitan cities there is a possibility of some increase in the availability of land for buildings therefore it cannot be called perfectly elastic. However there is a scarcity of land and for that reason the supply of land in metropolitan cities is inelastic.

A negative externality is when a certain economic entity does not pay the full cost that is incurred for the decisions made by it. It then ends up becoming an extra cost which the society usually bears. This is therefore called external diseconomy or external cost as everyone in the society ends up paying the social cost (Rowcroft and Black 2017). The marginal social cost exceeds the marginal private cost and this disequilibrium is what causes market failure as eventually everyone in the society is worse off. It is a spill over cost that is indirectly inflicted on a third party during an economic transaction where the producer and consumer are the first two parties and the third party is another individual, a resource or an organization. In the case of the heavy use of plastic bags and containers in Australia a variety of factors lead to negative externalities (Landon-Lane 2018). The damage caused to the aesthetics by landfills that contain plastic wastes, even marine life is getting greatly affected due to the huge amounts of plastic that have deposited on the sea beds. Apart from these the incineration of plastic releases harmful emissions. There lies a high degree of economic inefficiency as recycling plastic wastes is difficult. Other factors that are also responsible for the negative externality from plastic are that effective recycling infrastructure is not being designed in the absence of incentives and the legislation that has not provided for such incentives and so the usage of plastic is unprecedented and heavy. Another reason is the market for recycling input is not very stable (King, 2018). Government intervention plays a key role in regulating this negative externality that the heavy use of plastic bags and containers cause. Furthermore, market incentives that are aimed at promoting the recycling of plastic items lead to the creation of opportunities for further employment, saves a lot of costs and results in higher sustainability (D'Altrui 2017). Subsidies are also provided to promote research in the recycling industry that would in turn encourage the use of post-consumer plastic material in the manufacture of fiber where 54% of the input is PET recycled material as per the Australian Bureau of Statistics. This method of providing subsidy is an extremely effective strategy. Spreading awareness regarding the importance and the benefits of recycling plastic and the marginal benefits among plastic manufacturers and consumers is very effective in reducing externalities. Incorporation of marginal benefits to plastic manufacture can induce increased production through structural alteration (Horská, Pulatov and Abdirashidov 2015).

Figure 2: Creation of Welfare Loss

Source: Mankiw, G. (2016)

The welfare loss that results from the consumption of plastic containers and bags has been reflected in figure 2 where it can be clearly seen that negative externalities arises from their consumption. The market equilibrium will be attained at the position where MSB = MSC. Here MSB is the Marginal Social Benefit and MSC is the Marginal Social Cost. In this diagram the two axes represent the price and the quantity. The marginal social benefit curve represents the demand for plastic consumption. The MSC and MPC curves represent the supply curves and reflect the quantity of plastic containers and bags supplied or consumed where MPC is the Marginal Private Cost. The consumers would be consuming at the intersection of MSB and MPC. The difference between the two supply curves that is the marginal social cost and the marginal private cost curve is called the external cost.

The consumers should be consuming Q₁ amount of goods which would cost them P₁ amount but they are consuming Q amount incurring a cost P and this amount is lower because the consumer is enjoying an exemption of the social marginal cost because of the existence of negative externalities which is being borne by the society and environment. The shaded triangle area represents the welfare loss or the dead weight loss which arises from the divergence between the MSC and MPC. Thus, a ban on plastic in Australia will lead to lower usage of plastic containers and bags and this in turn will have an impact on its market price by shifting it toward the equilibrium. Therefore by looking at the graph, it can be concluded that there is a significant loss in the welfare due to high use of plastic containers and bags and so the equilibrium is changed.

Reference

Abs.gov.au. (2018). 6416.0 - Residential Property Price Indexes: Eight Capital Cities, Mar 2018. [online] Available at: https://www.abs.gov.au/ausstats/[email protected]/mf/6416.0 [Accessed 7 Sep. 2018].

Ashwin, A., Taylor, M.P. and Mankiw, N.G., 2016. Business economics. Nelson Education.

Becker, G.S., 2017. Economic theory. Routledge.

Connolly, E., La Cava, G. and Read, M., 2015, June. Housing prices and entrepreneurship: Evidence for the housing collateral channel in Australia. In Small Business Conditions and Finance, Proceedings of a Conference, Reserve Bank of Australia, Sydney (pp. 115-144).

D'Altrui, E.M., 2017. Bottle Water Bans: How can we curb the thirst for bottled water?. Elements, 13(1).

Friedman, M., 2018. Theory of the consumption function. Princeton university press.

Guide, G. (2018). Australia’s house price rises accelerating. [online] Global Property Guide. Available at: https://www.globalpropertyguide.com/Pacific/Australia/Price-History [Accessed 7 Sep. 2018].

Horská, E., Pulatov, A. and Abdirashidov, A., 2015. Consumption Towards Environmentally Friendly Consumer Behaviour: The Case Of Plastic Bags. Visegrad Journal on Bioeconomy and Sustainable Development, 4(2), pp.42-45.

Jacobs, K., 2015. The ‘politics’ of Australian housing: The role of lobbyists and their influence in shaping policy. Housing studies, 30(5), pp.694-710.

King, S.P., 2018. Technology and Competition Economics. International Journal of the Economics of Business, 25(1), pp.109-118.

Kohler, M. and Van Der Merwe, M., 2015. Long-run trends in housing price growth. Reserve Bank Bulletin, pp.21-30.

Landon-Lane, M., 2018. Corporate social responsibility in marine plastic debris governance. Marine pollution bulletin, 127, pp.310-319.

Leamer, E.E. and Stern, R.M., 2017. Quantitative international economics. Routledge.

Rowcroft, P. and Black, J., 2017. Toolkit of Measures for Managing Environmental Externalities in Urban Areas.

Stiglitz, J.E. and Rosengard, J.K., 2015. Economics of the public sector: Fourth international student edition. WW Norton & Company.

Varian, H.R., 2014. Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton & Company.